Globalization, Market Power, and the Natural Interest Rate

IMF Working Papers, May 6, 2019

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Strong globalization forces have been an important determinant of global real interest rates over the last five decades.
Globalization has been a key driver of changes in the natural real interest rate—i.e. the interest rate consistent with output at its potential and constant inflation.
Increased competition in goods and labor markets since the 1970s can help explain both:
- the large increase in real interest rates up to the mid-1980s, and
- as globalization forces mature and may even go into reverse, leading to incrementally rising market power, its subsequent and protracted decline accompanied by lower inflation.

Competition effects in goods and labor markets reduced markups and altered the natural real interest rate over time.
Mature or reversing globalization may incrementally raise market power (higher markups) and contribute to lower equilibrium real interest rates and lower inflation.

The analysis has important implications for monetary policy and the optimal pace of normalization.
Policymakers should account for changes in global market power and globalization dynamics when assessing the natural real interest rate and setting policy rates.